It pays to be poor in a crisis

The proportion of people living on, or below, the poverty line in the US exceeded that in Russia in September: the US had a 14.3 percent poverty rate and rising as of Sept. 15, according to the US Census Bureau; Russia’s poverty rate was 13.7 percent and falling, says Rosstat.

Wealth in Russia is rising because it has consistently tackled hard-to-do reforms that have delivered improvements in its ability to create wealth. Western countries face falling standards of living, as mature political systems are bad at making the changes needed to deal with the current crisis. The consensus politics of mature democracies works well when things are running smoothly, but not when there are big economic dislocations. If anything, the current crisis has only steeled the Kremlin’s resolve to push through the most liberal set of reforms yet under p resident Medvedev’s banner of “modernization.” Will it work?

There is a widespread perception that reforms in Russia have failed. Yet nearly every important indicator – size of the economy, personal income, stock market capitalisation – has expanded 10-fold in the last decade.

Reforms have been working, but in most cases while they have created wealth and opportunity, they remain a work in progress.

The retail sector was the first to take off more than a decade ago but its development is essentially apolitical: all the government had to do was free prices and ensure companies have access to capital. Retail turnover has been running well ahead of GDP growth, driven by the fast rise in incomes.

Reform of the telecommunications sector was the state’s first big top-down reform; starting around 2002, it has been a huge success. The quality of phone lines is beyond any comparison with Soviet-era telephony. There are 141 sim cards for every 100 people in the country, far ahead of any other Bric country, while the value of the leading companies has soared.

The point is that the Russian equity market looks very different depending on where you stand. From afar , it looks unattractive and volatile – fortunes can be made and lost in a financial quarter. But viewed up close, focusing on specific corporate and reform stories, and you see gems.

Thanks to its poor investment image, the Russian equity market is the only one of the Bric countries that has failed to re-rate. Russian stocks are currently trading at an average price-to-earning s (P/E) ratio (a widely used metric, where the lower the number the greater the perceived value of a stock) of less than 8, and this is expected to fall to 6.3 next year as corporate earnings recover. This compares to India’s 19, China’s 15 and Brazil’s 13 as of the end of September. In other words, Russia gets no credit from investors for the reforms already carried out.

However, look closer at the representative companies in each of the sectors that have been overhauled and the picture is the opposite. Take two examples: independent gas producer Novatek’s stock is currently trading at a P/E ratio of 20.1 and the shares of supermarket chain Magnit are trading at more than 30 – both look expensive, but investment banks still have both marked up as “buy”.

It looks like investors focused on Russia’s sectors in reform have realised the benefits and are heavily invested into the best stories in each of these sectors. But the reform story has yet to percolate out to the rest of the world, which is still painting Russia’s image in very dark colours.